The COVID-19 Scenario - Applicability of the Force Majeure Clause Any party seeking to rely on the Force Majeure clause may need to show that it was not aware, at the time of entering the contract, that circumstances giving rise to the event of force majeure were likely to occur. For example, now that the COVID-19 pandemic is omnipresent, if parties enter into a contract after this point and then have problems performing later, they may not be able to rely on force majeure unless the contract specifically covers COVID-19 and its consequences, and provides for what happens if it affects performance of the contract. Also, parties entering into fresh contracts since the outbreak should be using the COVID-19 force majeure clause and seek advice from the lawyers on appropriate drafting of the contract.
If the clause refers only to performance of obligations being prevented by the relevant event, then a party may not be able to rely on the clause if its performance has been made more difficult or delayed, but not completely prevented (in other words, it can still perform, but it is more difficult to do so and/or it cannot perform as expected).
Contractual obligations in the event of a pandemic As the global impact of the outbreak worsens, causing disruption to international trade and other commercial activities, the risk of businesses being unable to perform their contractual obligations increases. When a breach of contract arises, the affected party would normally sue the defaulting party for compensation. However, if the failure to perform the contract is caused by a pandemic, the defaulting party might be relieved by invoking the following as a defence:
- the pandemic has triggered the force majeure clause under the contract; or
- the contract has been frustrated by the pandemic. The purpose of a force majeure clause is to relieve the defaulting party (or all parties) from performing the contract or the remainder of the contract when an exceptional event or circumstance beyond the reasonable control of the parties prevents or hinders the performance of the contract. Sometimes, a force majeure clause does not seek to relieve the parties from the contract entirely, but only suspend its performance until after that event or circumstance.
Ways in which a force majeure clause would cover a Pandemic When the contractual definition of a force majeure event expressly includes a pandemic – adding a pandemic to the list of force majeure events can ensure clarity as to whether a viral outbreak would trigger a force majeure clause in a contract. In such a case, if the WHO or a state agency declares the outbreak to be a pandemic, there shall usually be no question that a force majeure event has occurred; or
- When the force majeure clause covers extraordinary events or circumstances beyond the reasonable control of the parties – such general, catch-all wording may be sufficient if it is determined that the factual circumstances caused by the pandemic are beyond the reasonable control of the parties. It is also possible that the consequences of or relating to a pandemic (e.g. government policies, travel restrictions, etc.) could themselves amount to a force majeure event if they are beyond the reasonable control of the parties.
Ways in which the force majeure clause is enforced Whether a force majeure clause would apply depends on the wording regarding the triggering event. If the clause provides that the triggering event must "prevent" the performance of the contract, the party relying on it would usually need to prove that the performance is physically or legally impossible. The fact that the event has made the performance difficult or unprofitable is unlikely to be sufficient to trigger a typical force majeure clause. On the other hand, if the clause provides that an event that causes the performance to be "hindered" or "delayed" could trigger the clause, it is likely to be adequate to demonstrate that the performance is substantially more onerous. However, an increase in the cost of the performance alone is still unlikely to be sufficient to trigger the force majeure clause. Furthermore, the party invoking the force majeure clause should demonstrate that it has taken all reasonable steps to mitigate the event as well as its effect on the performance of the contract (e.g. identifying alternative sources or keeping a sufficient reserve of materials that could become limited in supply).
Frustration of contract by a pandemic A contract is frustrated when there is a supervening event that changes the nature of the outstanding contractual rights and/or obligations to the extent that the parties could not have reasonably contemplated such change at the time of the execution of the contract. In such a situation, the party may be excused from performing the contract because the primary purpose of entering into the contract, and its performance have been rendered radically different. The change in circumstances must be attributable to an external event that is not caused by the default of the party relying on it. Also, the force majeure clause may be triggered if the contract does not make enough provision for such supervening event. Therefore, if a COVID-19 pandemic fundamentally changes the principal purpose for the parties to enter into the contract such that its performance is radically different from what was originally contemplated, the defaulting party may be excused from performing the frustrated contract.
Frustration of contract should only be invoked in the event of a pandemic if the contract does not contain a force majeure clause or the clause does not cover a pandemic as discussed above. The scope of the application of frustration is narrow as the courts would not invoke the doctrine of frustration lightly "to relieve contracting parties of the normal consequences of an imprudent commercial bargain". If the contract already provides for a pandemic event (under a force majeure clause for instance), such express provision would usually prevent the contract from being frustrated. Frustration of a contract would not occur merely because the event has made the performance difficult, more costly, or onerous. Nor would a contract be frustrated simply due to an unforeseeable event that did not otherwise change significantly the outstanding contractual rights or obligations from what the parties could reasonably have contemplated at the time of the execution of the contract.
OTHER CONSEQUENCES FOR CONTRACTS:
- Price adjustment clauses - parties may seek to adjust all or part of the contract price for a commodity due to increased costs e.g. due to increased supply chain strain as a result of COVID-19.
- Limitation or exclusion clauses - parties may increasingly seek to rely upon limitation or exclusion clauses (especially in the absence/ inapplicability of a force majeure clause) to limit or exclude liability for non-performance.
- Change of law clauses - a party could rely on a "change of law" clause in a contract (entitling either party to terminate or renegotiate the contract, where a change in the applicable law makes it impracticable or impossible for a party to perform its contractual obligations).
- Material Adverse Change (MAC) clauses – the outbreak of COVID-19 could trigger a MAC clause in a contract. A MAC clause is a term found in some agreements which allows a party to refuse to proceed if certain events occur after the contract date. Whether events related to the COVID-19 pandemic will amount to a MAC will depend on the terms of the clause and the specific circumstances. It may be possible to invoke a MAC clause if events have taken an unexpected turn, after the contract was entered into, which has had a dramatic impact in the particular circumstances of the transaction. Given the extreme circumstances resulting from the COVID-19 pandemic in many areas, this may be an available line of argument, but it will all depend on the circumstances. Given the fact-specific nature of the enquiry, previous case laws may be of limited assistance in determining the outcome of a future case, which will turn on the wording of a different clause agreed against different background facts, and the different circumstances alleged to constitute a MAC.
- Disruption to supply chain logistics – if existing supply chains fail or are significantly impacted, businesses will be forced to find alternative solutions.
- Distress/Insolvency – the spread of COVID-19 has already resulted in an increase in companies experiencing financial distress as they try to mitigate the financial impacts of supply chain issues coupled with lower customer demand. Companies with already high debt levels are finding existing credit lines withdrawn at a time when they need to pay suppliers who are able to deliver on time while not receiving customer payments. Likewise, planned refinancing and distressed M&A activity is being delayed (as a result of travel restrictions and other measures), with the result that companies are finding it more challenging to execute and implement time critical turnaround plans. As a result, companies may be forced to seek formal and informal protection from their creditors.
Principles in other jurisdictions Prior to the decision in Taylor vs. Caldwell, (1861-73) All ER Rep 24, the law in England was extremely rigid. A contract had to be performed after its execution, notwithstanding the fact that owing to an unforeseen event, the contract becomes impossible of performance, which was not due to the fault of either of the parties to the contract. This rigidity of the common law was loosened somewhat by the decision in Taylor (supra), wherein it was held that if some unforeseen event occurs during the performance of a contract which makes it impossible to perform, in the sense that the fundamental basis of the contract goes, it need not be further performed, as insisting upon such performance would be unjust.
In Gulf Oil Corp. v. FERC 706 F.2d 444 (1983), the U.S. Court of Appeals for the Third Circuit considered litigation stemming from the failure of the oil company to deliver contracted daily quantities of natural gas. The court held that Gulf- as the non- performing party-needed to demonstrate not only that the force majeure event was unforeseeable but also that the availability and delivery of the gas were affected by the occurrence of a force majeure event. The terms of the agreement and the intent has to be understood to determine the effect of force majeure clause.
In Phillips P.R. Core, Inc. v. Tradax Petroleum Ltd., 782 F.2d 314, 319 (2d Cir. 1985), it was observed that the basic purpose of force majeure clauses in general is to relieve a party from its contractual duties when its performance has been prevented by a force beyond its control or when the purpose of the contract has been frustrated.
In Transatlantic Financing Corp. v. U.S. 363 F.2d 312, the D.C. Circuit Court of Appeals affirmed a finding that there was no commercial impracticability where one party sought to recover damages because its wheat shipment was forced to be re-routed due to the closing of the Suez Canal. The court of appeals held that because the contract was not rendered legally impossible and it could be presumed that the shipping party accepted "some degree of abnormal risk," there was no basis for relief.
Under Hong Kong law, if a contract is otherwise silent, a contract party will need to demonstrate that the outbreak of SARS in 2003 frustrated the purpose of the contract. This is a question of interpretation that depends upon the circumstances surrounding the performance of the contractual obligations and the impact of the SARS outbreak, as construed by a Hong Kong court. This is inevitably difficult to forecast. However, the express inclusion of the word "epidemic" in a force majeure clause provision certainly helps further the argument that a force majeure event has occurred (but not that a contract party is necessarily relieved from performance).
Some landmark rulings in India Deliberating on what is to be considered as a force majeure, in the seminal decision of Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310, the hon'ble apex court had adverted to Section 56 of the Indian Contract Act. The Supreme Court held that the word "impossible" has not been used in the section in the sense of physical or literal impossibility. To determine whether a force majeure event has occurred, it is not necessary that the performance of an act should literally become impossible, a mere impracticality of performance, from the point of view of the parties and considering the object of the agreement, will also be covered. Where an untoward event or unanticipated change of circumstance upsets the very foundation upon which the parties entered their agreement, the same may be considered as "impossibility" to do as agreed. Subsequently, in Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821, the Supreme Court also referred to the English law on frustration and concluded that a contract is not frustrated merely because the circumstances in which it was made are altered. In general, the courts have no power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.